Markets to Open Lower - Profit Taking on Tap

December 17, 2008 – The futures are indicating lower openings this morning after markets rallied yesterday on a larger-than-expected rate cut from the Fed. Also ahead, OPEC is expected to announce a cut in production by 2 million barrels per day as of January 1 to help buoy prices amidst slowing global demand. Traders will also be adjusting to more downbeat corporate guidance, announcement of more job cuts and uncertainty about the situation in Detroit.

Pressure continues to mount for the Bush administration to cave and pull funds out of the $700 billion bailout package for the financial sector to help the auto industry. The pressure is coming from Detroit and Democrats, generally. The GOP is generally against the move. In either case, here is what is certain: jobs will be lost in Detroit, and the Big Three will be back sometime before mid-2009 looking for additional help – both don’t bode well for investor sentiment.

On the heels of the Fed’s massive rate cut yesterday, the dollar is retreating this morning against the euro, which is getting 1.4057, up 0.35% this morning. Just a week or so ago, the euro was below 1.3 against the dollar. We have been forecasting that the dollar is going to buckle under the massive amounts of debt that is being added to our national balance sheet, and yesterday’s Fed cut is just another catalyst to accelerate that slide. If the Fed isn’t careful, we could be looking at a deepening recession in 2009 with inflationary pressures. With the dollar sliding, gold is rallying, up $11.90 this morning to $854.60. We remain bullish long-term on gold, and our bullishness is 100% driven by our bearishness toward the dollar. By this time next year, we expect to see the euro pushing to 1.60 and above against the dollar, while gold tips the $1,000 level.

In international markets, unemployment in Britain is up 137,000 to 1.86 million, representing an unemployment rate of 6%, according to the Office for National Statistics. The Czech Republic cut its key interest rate by 0.5% to 2.25%. Portugal’s finance minister is threatening to take away credit guarantees from the country’s banks it they don’t pick up the pace to ‘normal’ lending.

·         The latest companies to cut jobs are Newell Rubbermaid (8% to 10% of salaried workforce and a hiring freeze); Western Digital (up to 2500 jobs); BNP Paribas (about 800 jobs)

·         More negative news in the auto industry (worldwide):; while Honda (NYSE:HMC) cut its profit forecast this year to 185 billion yen ($2.06 billion), down from the 600 billion yen in profits earned last year, lowered its sales forecast to 10.4 trillion yen ($116.9 billion) from 11.6 trillion yen ($130.6 billion) while management will take a 10% pay cut. Honda’s worldwide unit sales are expected to reach 3.77 million units and management is not setting any targets for 2009;

·         And more negative news in the financial sector: BNP Paribas said its investment banking division has lost €710 million ($972 million) through November – a major turn from the previous statement that through nine months it had a pretax profit of €879 million. October and November must have been dismal for the firm; while AIG (NYSE:AIG), which has already recorded more than $60 billion in write downs, is being rumored this morning to be readying to record another $30 billion due to incorrectly valuing its holdings;

·         ConAgra (NYSE:CAG) said Q2 revenue increase 10.6% to $3.26 billion, while profit fell 31% Y/Y to $168.1 million, or $0.37 per share;  

·         General Motors (NYSE:GM) reported Q2 revenue of $4.01 billion, up 8% Y/Y, and earnings of $378.2 million, or $1.09 per share, down from $390.5 million, or $1.14 per share last year

In terms of what we expect in today’s session, we think the markets are going to pull back. Then again, we have been stocks to turn to the lower end of their current ranges over the past couple weeks while instead they have trended higher. We are happy to be wrong, and to see that there has been an appetite to support stocks in spite of the steady stream of deteriorating economic data and downbeat corporate guidance, but we still don’t see any catalysts to trigger further strength at this point.

The fact that stocks have moved higher in recent sessions may be indicative of the fact that traders are betting that we have put in bottoms. To be sure, yesterday’s 359 point rally on the DJIA was a reaction to a larger than expected rate cut from the Fed, but even more so, a reaction to a clear signal that the Fed is going to throw everything it has at the economy to revive its pulse. In addition, yesterday’s rally was on 22% increase in volume from the day before which signals that the rally was broad-based.

We still think the DJIA can turn back to the mid-7,000 level on short order, given sufficiently depressing economic data. The good news is that there aren’t any reports on tap this week which will create that bad of a mood. Tomorrow’s weekly jobless claims are already expected to be negative, and traders will definitely key in on that data to take stocks lower. But again, expectations are already downbeat here so we doubt, unless the number comes in significantly worse than expected, that the reaction will be too bearish.

Next week is pretty light, as well in terms of economic data. But keep in mind that the final revised number for Q3 GDP will be coming out on Tuesday. This will be an ugly number, and it will stir the pot in terms of refocusing the Street on what the Q4 number is going to look like, and it will almost certainly be much worse than the Q3 number. This topic will take the focus of traders heading into the Christmas holiday, and it is, in our opinion a definite bearish catalyst. So we think that there are a more reasons to think stocks will pull back in the near term than there are for them to turn higher. Our advice remains to protect against downside risk at current levels.